Sappi Limited (SAP) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to Sappi Financial Results Announcement Q1 2023. [Operator Instructions] I will now hand the conference over to CEO, Steve Binnie. Please go ahead, sir.

Thank you. Good day, everybody, and thanks for joining. As always, I'll move through the investor presentation, calling out the page numbers as I move along. And I'm going to start on Page 3, which is the highlights for the quarter. Pleased to say that it was our best ever first quarter EBITDA of $290 million, which is a 21% rise year-on-year. And under the circumstances, with the more challenging economic environment, we're very proud of that. The other thing I would call out to you is that this -- the prior year did have a 53rd week. And if you equate that to sales volumes, if you're comparing year-on-year, that was about 7.5% of sales volumes. So in order to get a true comparison, you should back out the 7.5% from the prior year. A higher profitability came from year-on-year pricing gains from our paper products, which offset cost inflation and lower sales volumes. During the quarter, we began to see the market softening, and that was as a consequence mainly of rapid downstream inventory accumulation and that itself was as a consequence of the bounce back and the logistical challenges that occurred after COVID, then there was high order activities and ultimately, a buildup of downstream inventories across the board. And then at the same time, there has been a slowing of the global economy and in anticipation of lower consumer spending, which impacted across all our segments. The net debt to EBITDA under one time. So pleased with that as well. Moving to Page 4, which has just got the quarterly EBITDA. And you can see this only goes back the last 4 years, but you can see, relatively speaking, Q1, a good performance year-on-year, and obviously, giving us the healthy margins that we delivered. Moving to Slide 5, the earnings bridge from last year to the current year, and it tells all the stories. Firstly, lower sales volume linked to the slowing demand, mainly inventory accumulation, as I referred to. But then benefiting from higher selling prices across all our segments, which enabled us to offset higher raw material costs. And once again, it's across the board, the higher cost, and I think we've got another slide on that just now. And then higher fixed costs coming through that wage inflation and salary inflation all to contribute towards the $290 million that we achieved in the current quarter. Slide 6 is something that we've been sharing with you in recent times. But really, just to put things in perspective, across all our major cost categories, significant rises over the last few years. But things are beginning to turn. You can see in the last quarter across most of the categories coming down. And in particular, energy as gas prices and other energy prices have come down as the pressure has reduced. Slide 7 has our net debt to EBITDA evolution and a great story to tell. In the current quarter, we did generate more cash, but we did get impacted negatively by the movement in exchange rates. You all know that we've got a significant portion of our debt in euros. And obviously, we all know that the dollar weakened during the quarter against the euro that roughly accounts for about GBP 100 million additional debt. But all in all, good cash generation. And as we move through the rest of the financial year, we will, in absolute terms, we will continue to bring down our debt numbers. On Page 8, the maturity profile of our debt and you can see that nothing major. The one dark blue line in 2024 relates to our securitization structure, pleased to tell you that, that's been renegotiated and extended to -- that was renegotiated this month or in January. And that's extended to 2026. So really, we don't have any material debt refinancing in the next few years. Slide 9 has the cash flow on the left-hand side, just confirming the cash generation and the free cash flow. Typically, Q1 is a reasonable quarter. But as you know, if you follow Sappi over the years as we get to the Q4, that's when we generate the most of our cash on an annual cycle, and we would expect that to continue. CapEx for the year is consistent with what we gave last quarter, $430 million, of which $70 million is -- relates to the Somerset conversion. That starts slow, obviously, and then start to build up as this year unfolds and we get into 2024. Turning to a couple of the major cost categories. And firstly, on pulp, which is on Slide 10. You can see that the Chinese prices of paper pulp have started to come down. The Europe one is still relatively high. North America is not on here, but it's the same in North America. Those are still at relatively high levels. What we see typically and we've seen in the past as well is that the U.S. and Europe tends to lag the Chinese. So we do think that will be a positive opportunity as we move through the rest of the financial year. And then on Slide 11, the gas. And we've shown this slide before, lots of volatility. We saw the peak before the European winter. This is the European gas prices. The winter ended up being milder than everybody anticipated. There was high storage levels across Europe, and the situation improved quite dramatically, which has brought down gas prices to the current 58, I think, is the current number. So once again, that will help reduce the pressure on our business. Then moving ahead to the segmentals. And firstly, the product segments, Slide 13. Year-on-year selling prices, up 9%. However, as you know, and we reported in the earnings announcement, the actual spot prices for dissolving pulp did come down during the quarter. I think they reached a low in early January of about $880 a tonne. And that's linked to high retail inventories downstream and a significant lowering of order activities, which came all the way back up through the viscose producers who lowered their operating rates and ultimately, that lowered demand for dissolving pulp. What I will say is that subsequent to this, DP prices have actually started moving upwards again. Activity is picking up in China and across all the viscose producers. So there's some very positive signs coming out of that market, and we are optimistic about the prospects for pricing, and I'll talk about that a bit more when we get to the outlook statement. But all in all, our margins were lower because of the higher cost inflation and lower sales. impacting on sales was we did have the -- we had the electrical outage in the KwaZulu-Natal area, which impacted the 3 mills and that lowered volumes year-on-year as we compare. Moving to Slide 14, the Packaging & Specialties segment. It's important to point out that underlying demand is still relatively stable. However, as we engage with our customers, they do have high inventory levels. So they're working their way through that, and we do expect that to normalize pretty soon. The year-on-year selling price increases supported the EBITDA growth. And you can see it's up 24% year-on-year to give us an EBITDA margin of 18.4%. Then in graphics on Slide 15, weaker market conditions, obviously, coming off the significant highs and the record demand and profitability that we achieved in the prior year. Once again, it's a story of higher inventories. We see that at merchants, we see it of printers. And they were once again working through their inventories. What we did is we matched ourselves and lowered our production levels. So we did take downtime during the quarter, but our focus was on protecting selling prices. And that's why we were able to deliver the good margins that you see here, the 15%. Those increases in selling prices or the higher level neutralize the impact of the cost inflation and lower sales volumes that I've talked to. Then turning to the Europe -- sorry, the geographical segments and starting in Europe. Year-on-year sales down 32%. Once again, I call out that there's an extra trading week in the prior year. You back that out and year-on-year comparative would be closer to 25%. We took significant production downtime, but our drop in demand for the categories that we're in, in graphic paper is in line with the market. We have not lost market share. We're in line with the market. The pricing gains that we have experienced offset cost inflation. But as I said earlier, the high inventories has meant that there's lower demand, and we were able to keep our selling prices stable despite more challenging demand conditions. Then turning to North America, another strong performance. Sales tonnes down 17%, once again, extra sales week there, backing that out. There was a little bit of softness compared to recent quarters, and again, it was linked to high inventories. But the other thing that is the bullet at the bottom. We did have a real upgrade project at Cloquet. So that took out a little bit of volume. But generally, the North American market was better than the European market, although we did see some slowdown, particularly in December. And then turning to South Africa. Significant year-on-year cost inflation impacted profitability. I've talked about DP already, so I'm not going to repeat that, but we did make good progress in terms of alternative shipping through Maputo. And our ultimate goal is to move all our Ngodwana export volumes through Maputo we're on track to be able to do that. On the paper side of the South African business, container bulk markets were still robust across the board. And interestingly, all our other domestic paper markets like office paper and newsprint. Sales volumes were good, and pricing improved profitability in the Graphic Paper segment. We do sell some graphic paper in South Africa. Then Slide 19 is our Thrive 25 pillars, and this is a slide you've seen many times. I'm not going to repeat them, but just to call out a few things. Firstly, on operational excellence. Obviously, things are a little bit challenging at the moment because you take a little bit of production downtime and that affects efficiencies, and we're going to manage our way through that. But with costs coming down, we are looking for cost-saving opportunities and also on the supply chain, with supply chain improving and more capacity coming on board there, we do think that there are opportunities there to bring down costs and improve our customer service, always focused on safety and striving for 0 injuries in the workplace. Enhancing Trust, Obviously, we recently announced our science-based targets. We're on track for that. We are looking for opportunities to lower our carbon footprint, looking for alternative energy sources, particularly in South Africa. And ultimately, it's a number you've seen previously, we estimate that our sustainability CapEx spend is about $70 million a year, and you've seen that, and it's embedded in the $430 million that you had the guidance that we gave you earlier. And then in terms of growing our business, a number of smaller projects, which we've shared with you in the past that are either just being completed or close to completion ramping up labeling at Gratkorn, the new quarter that was installed at all felt in the prior quarter, and that's ramping up, and we've got orders there now coming off that. We had a debottlenecking at Somerset PM1, which gives us an additional 30,000 tonnes. And then longer term, the conversion of the Somerset PM2 machine, which is obviously going to give us more tonnes and move us into a higher growth segment. And then sustaining our financial health, I talked last quarter about our target of keeping our debt below $1 billion. We're well on track to do that. and committed to maintaining at those low levels. And this is a very important strategic priority for us moving forward. And we will continue to look for opportunities to optimize our exposure to graphic paper as well. Slide 20. Sustainability is at the core of everything we do. It's now part of our capital allocation process. We measure the impact of all the new projects that we do and what it does for the targets that we've set ourselves. So it's embedded across the business. Slide 21, just as some of the ESG things that we're working on, many of these you've seen before, just a couple of callouts. The ISS and MSCI ratings both improved during the quarter. So pleased with that. We maintained our Level 1 BBBEE rating at Level 1. So very proud of that. And then obviously, on the right-hand side, you've seen our annual report came out in our new '22 sustainability report has been published. Slide 22, as our science-based targets, as I said earlier on target to deliver these, and it's an important part of our business. Moving forward to the outlook statement. And it's fair to say that in the short term, things are likely to be negatively impacted by the combination of the final phase of the downstream inventory destocking that I referred to, and that resulting impact on sales volumes across all our market segments. However, there are positives coming through. And I mean, firstly, I've talked about it many times on the call. Costs are starting to turn, which is going to relieve the pressure somewhat. And then if you look at some of the macro factors that are out there, the Chinese economy is opening up, we're seeing activity picking up specifically in the viscose segment and obviously, demand for DP, so things are moving there. Inflation looks like it's peaking globally, and that's going to release pressure for consumers. So all of that gives us optimism as we move towards the end of this financial year and into the next financial year. Just repeating some of the things that we've talked about, but cost inflation is expected to receive natural gas prices coming down, pulp prices expected to decline, delivery costs are already coming down and even chemical costs. So all of that is positive. At the end of the last quarter, we announced the divestment of the 3 European mills. That transaction is expected to close during the second quarter. There's a number of conditions that have to be fulfilled and we're on track to do that. The cash proceeds are expected to be received -- well, the cash proceeds, obviously, immediately on closing, and then the receivables will be collected in the second and third quarter. So we're still on track there. CapEx for the year, $430 million, as I said, $70 million for the Somerset conversion. So taking all of that into account, the macroeconomic uncertainty, we are coming off our best year ever. So we do anticipate a return to more normalized earnings in 2023, with Q2, the expected to be the most challenging with a subsequent recovery. And because of that, Q2 will be lower than Q1. So operator, that's my presentation. I'm going to hand it back to you now for questions.

[Operator Instructions] The first question is from James Twyman from Prescient.

I've got a few questions. The first one was, working capital went up fairly substantially, especially given the big increase last year. I was just wondering what the causes of that were? Whether there was a surplus of inventory given the weak demand that you've seen? And then the second one was, is it possible to be able to maintain prices at this very high level and it's impressive that you've done that so far, given the very weak demand and the sharp fall in gas costs, which was one of the reasons for prices being pushed up. So those are the questions. Also, you have the cost maintenance cost for the Somerset mill in the quarter.

Just on the first question on working capital, I'll let Glen go into more detail, but it's not an inventory story. It's still linked to receivables because selling prices were still going up. If you're comparing quarter-on-quarter. So we're still getting to the peak impact of selling prices on our receivables number. But Glen, you can all...

So that's basically the reason, and we're anticipating a cash inflow in the second quarter, and it will be recovering about half of that outflow. Just to your question, specifically, James, on the inventory side, we managed that risk. We took our downtime, it's mainly Europe we're talking about here. We took our downtime, and we're not sitting with excess inventory. So we've managed that risk very well. The selling prices, yes, our focus has been on -- has been to protect our selling prices. costs are still high. Yes, we've taken a downtime because of lower demand. But we're of the belief that if we had lowered prices, it would not have attracted more demand because it's an inventory destocking that's underway. So we are striving to keep selling prices, and we've been able to do that, and we still -- our selling prices are still at those levels. So we haven't seen declines yet. Then on the third point on the cost of Somerset, Mike?

The summer stood outage was included in the quarter, and it was approximately $18 million.

The next question is from J. Clark from SBG Securities.

A couple of questions from me, please. Just first of all, I wonder if you could give us just a little bit more on the ground color on BSF operating rates and what you're seeing there? Second one, have you got any -- can you share with us what the sort of EBITDA outcome was for the 3 mills that you're selling, just to give us some kind of a base upon which to think going forward if the sale is going to progress in Q2 and through into Q3, just what we should think about in terms of margin change or in terms of EBITDA and then just on Somerset on the PM2, you're taking off the 235,000 tonnes of coated woodfree. Is that off already? Or is that going to come off now in this coming quarter in terms of just overall production? And should we sort of strip that out just to be replaced by the new project in '25? Or when should we strip that on?

On the VSF operating rates, I'll let Mohamed elaborate further. But during -- well, during the quarter that we just reported on, operating rates went all the way down, and they were across the board at 50% levels. We have seen a subsequent recovery. And I mean at one point in time, for example, the Chinese producers were not making this cost at any kind of volumes. But let me hand you over to Mohamed.

Just specifically on China because that's where you have a public information. What we've seen just before Chinese New Year, the operating rate as an industry average was around close to the 55% post Chinese New Year. It's now up to 63% as of this morning, and there is a lot of market information coming out of buyers of dissolving pulp in China that, that rate is likely to go higher. One of the reasons that's driving that also is that the buying activity for viscose staple fiber has started to improve again. We've seen the stock levels that the VSF producers have been holding, starting to come off. It peaked just before Chinese New Year at around 30 days. The long-term average is about 20 days, so not too much higher than the long-term average, but it has now started to turn. And we've also seen VSF prices starting to lift just before Chinese New Year, some of the major VSF producers announced at 200 to 300 per tonne price increase. And we've started to see that price increase take hold just after Chinese New Year. As of this morning, VSF prices in China is now 13,200-13300 per tonne and moving towards 13,500. And what -- and the other thing we are starting to see is, as a result of that improvement in the VSF operating rate, there's increased activity in terms of interest in buying dissolving pulp. As a result of that, we've started to see the dissolving pulp prices now move up. It has moved from about 80 in mid-January. This morning, the CCF index is at 898 and there's been price increase announcements, which is in the public domain of 900 for hardwood dissolving pulp and for softwood dissolving pulp 950.

And the second question, in terms of the 3 mills that we're divesting, well, the first comment I would make is that the drop in sales volumes that those 3 mills experience is broadly, broadly in line with the drop the overall European business has encountered. I think the best way to think about this because Q1 is obviously still at elevated levels relative to historical norms. And these 3 mills on a normalized basis are making about -- sorry, $50 million EBITDA per annum. And then on Somerset PM2, I'll let Mike go into more detail. But the mill will only -- sorry, the conversion will only be completed in late '25 financial year. And although we're taking a little bit of downtime in the U.S. at the moment, we would expect to be able to fill our mills once again. And Mike, maybe you can elaborate further on that.

Steve, we plan to run the machine full to Q2, Q3 of 2025. There might be a minor downtime before that. But the machine will run coated freesheet or C1S grades until that time. And the conversion will go completely to packaging after the outage in Q2, Q3 and '25.

And the next question is from Brian Morgan from Morgan Stanley.

In the outlook statement, you talk about a normalized level of earnings. Could you elaborate on that a little bit?

Look, what we do is we look back at the last few years, and obviously, there's been a lot of volatility to recover, right? But Historically, the average has been close to the 800 mark. Obviously, we've made positive changes to the business in terms of shifting volume from lower margin products to higher margins. So we would expect a positive contribution for that. So I'm not going to give you a definitive number, but that gives you a rough indication of where we're thinking.

So 800-plus business improvements, minus the 50 that you're setting.

Well, the outlook statement did take into account the sale.

All right. So then on just graphic paper volumes and just thinking just following on the previous question about strategy, et cetera. Once you've sold these mills, you've obviously got to have better quality cutted woodfree mills in Europe. Would you be looking to keep those mills full even when the industry is in periods of more or higher decline rate than normal?

Yes. I think at the moment, let's talk about woodfree because it's predominantly coated woodfree in Europe. And the market demand for coated woodfree in the quarter was down in the high 30s percent. It's -- and that's in line with what we experienced. That is very clearly an inventory adjustment. That's not where the market demand is going to be. Now it's difficult to pinpoint exactly when that inventory adjustment is complete. It won't be in Q2. We are anticipating that it will be sometime in Q3. And then we would expect a bounce back in volumes. And from that point onwards, then that would enable us to get back to fuller machines and more optimized levels of production. We always talk about a decline of a longer-term decline of 6%, and we stick to that. So we do anticipate a bounce back in the second half of the year.

So you don't think that there's been demand destruction as a result of higher prices?

Well, interestingly, if you look at the journey through the last few years and the bounce back in recovery, I think it's fair to say that the demand last year was better than everybody had anticipated and had eliminated a lot of the natural drop in demand. So there will be a higher decline in the current year because you're coming off the elevated levels. So we think there's 1 year, and we estimate that for this year, it will be somewhere between 10% and 15%. Marco, I don't know if you want to elaborate further.

Yes, that is correct, Steve. And to the point Brian was making, we don't necessarily see a further structural elimination of the market, and we're counting on a rebound that will get us on track exactly as Steve said, for a structural decline of 5%, 6% in graphics.

So in summary, Brian, there's 1 year here where you're going to get between 10% and 15% and then thereafter, a resumption in the 5% to 6%.